The Pros and Cons of an Escrow Account

December 29, 2014

What is an escrow account and should you have one for your new mortgage? Sometimes called an “impound account,” an escrow account is a trust account held by your mortgage lender to collect and pay your homeowner’s insurance and property taxes.

Basically, your lender adds 1/12 of your annual homeowner’s insurance cost and property taxes to each monthly mortgage payment. For example, if your annual property taxes are $2,400 and homeowner’s insurance $1,200, your lender will add a total of $300 to each mortgage payment to cover both ($200 taxes + $100 insurance). When it’s time to pay your insurance and taxes, the lender will disburse the funds from your escrow account.

Typically, an escrow account isn’t required if you have 10% or more equity in your home. For low-down payment mortgages, such as an FHA loan that only requires a 3.5% down payment, an escrow account is required. But if you have the option whether or not to have an escrow account, what should you decide? Let’s take a look at the pros and cons of escrow accounts.

The Pros

· Lower mortgage costs. You may be eligible for a discount on your interest rate and/or closing costs by electing to have an escrow account.

· Your lender is responsible for making the payments. You’ll never need to worry about making your homeowner’s insurance and property tax payments on time. Your lender will automatically do both for you.

· No need to set aside extra funds each month. The exact amount you need for taxes and insurance will be automatically added to your monthly principal and interest mortgage payment. (You may have seen this referred to as “PITI,” which stands for “Principal, Interest, Taxes and Insurance.”

· No big bills to pay around the holidays. If making a hefty property tax payment around the holidays would stretch your monthly budget a little too thin, then an escrow account may be right for you.

The Cons

· Escrow accounts tie up your funds. If you’re already good at saving money, you may decide to keep control of your homeowner’s insurance and property tax funds, until it’s ready to pay the bills. In the meantime, you’d have the ability to earn interest on those funds. In the example above, you’d simply set aside $300 each month to cover taxes and insurance. And until those bills are due, you could put that money to work for you.

· Upfront payment to set up your escrow account. You may be required to deposit several months of property taxes when you open the account, depending on the time of year.